Bail me out Bennie

Peter Schiff
Mar 28, 2008

Now that the Fed and the Treasury
Department have clumsily come to the rescue of the financial
titans of Wall Street, it is now politically dangerous to resist
similar pleas from just about everybody else. Populism is emerging
as a dominant theme is this election year, and with so much largesse
showered on Bear Stearns and JP Morgan Chase, politicians are
demanding even more generous terms for consumers. In Washington,
it seems that two wrongs apparently make a right. Another downside
to corporate bailouts is that they provide the critics of free
market capitalism with plenty of excuses to weigh down American
economic vitality with even more unnecessary regulation.

In the first place, the current
mess did not result from a failure of the free market, but from
too much government interference. The real estate bubble, and
the shaky securitized products it spawned, resulted from the
Fed artificially setting interest rates too low. Had interest
rates been allowed to find their market levels, rather than be
set by government decree, the real estate bubble never would
have been inflated in the first place.

In a nation short on savings
and heavy with debt, the free market would naturally set interest
rates quite high. With lots of demand for credit, but a limited
supply of savings, the risk of lending and therefore the price
of credit (interest rates) would be high. Although onerous to
borrowers, high rates would have both encouraged saving and discouraged
borrowing. In the end, these market forces would reduce interest
rates and produce a more stable balance between savings and consumption.
However, the Fed did not want American consumers to be subjected
to free market discipline that might otherwise reign in their
non-stop spending. After all, reckless consumption was falsely
believed to be the engine of our prosperity.

So the Fed fixed the price
of credit (interest rates) well below the rate that would have
been set by the free market. This sent false economic signals
to the market that more savings were available than actually
existed, leading to an over-investment in housing. Also, by
keeping the rate of interest below the rate of inflation, rampant
speculation was encouraged, and the foundation was laid for the
very type of mortgage financing that has now come back to bite
us.

In the second place, no one
on Wall Street should be bailed out. The effects of the bursting
of the housing bubble should be dealt with by the market, despite
the fact that the underlying bubble itself was a byproduct of
government intervention.

Apart from the problems created
by interfering with the market's attempts to restore balance
and reallocate resources, bailouts create all sorts of moral
hazards. After all, why should bailouts be limited to investment
banks or overstretched homeowners? What about renters who also
borrowed too much money? What about those behind on their credit
cards, auto or student loans? Why shouldn't they get bailed
out? How about small entrepreneurs whose start-up businesses
failed -- should they get bailed out as well?

In market economies all sorts
of people lose money, sometimes as a result of circumstances
entirely beyond their control. While this is clearly not the
case for most homeowners and mortgage lenders, some would obviously
fall within that category. However, it is not up to government
to rescue them. Even if some borrowers and lenders were lead
astray by the false economic signals sent by the Fed, they are
never-the-less responsible for any losses they might have incurred
as a result of following them. The real danger is that while
government interference is actually at fault, it's the free-market
that ends up taking the blame.

***

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Mr. Schiff is one of
the few non-biased investment advisors (not committed solely to
the short side of the market) to have correctly called the current
bear market before it began and to have positioned his clients
accordingly. As a result of his accurate forecasts on the U.S.
stock market, commodities, gold and the dollar, he is becoming
increasingly more renowned. He has been quoted in many of the
nation's leading newspapers, including The Wall Street Journal,
Barron's, Investor's Business Daily, The Financial Times, The
New York Times, The Los Angeles Times, The Washington Post, The
Chicago Tribune, The Dallas Morning News, The Miami Herald, The
San Francisco Chronicle, The Atlanta Journal-Constitution, The
Arizona Republic, The Philadelphia Inquirer, and the Christian
Science Monitor, and has appeared on CNBC, CNNfn., and Bloomberg.
In addition, his views are frequently quoted locally in the Orange
County Register.

Mr. Schiff began his investment career as a financial consultant
with Shearson Lehman Brothers, after having earned a degree in
finance and accounting from U.C. Berkley in 1987. A financial
professional for seventeen years he joined Euro Pacific
in 1996 and has served as its President since January 2000. An
expert on money, economic theory, and international investing,
he is a highly recommended broker by many of the nation's financial
newsletters and advisory services.